Increasing house prices is one of the most frequently discussed – and worried about – topics.
One of the most fascinating items on display at the British Museum is a 13th century mortgage, carved into a stone brick.
Dated Sunday 11 June 1217, and written in Sanskrit mixed with the local dialect in Nagari script, the enormous brick records a mortgage against a loan. (I suspect that if you took out enough mortgages, you could build a house out of the mortgage bricks!)
The word ‘mortgage’ is one which inspires dread in many people, and for good reason. After all, it is derived from the Old French for ‘death pledge’ (think of mortuary, engage) According to the Online Etymology Dictionary, mortgages are so called ‘because the deal dies either when the debt is paid or when payment fails’.
This association with death is evident in an advertisement I saw on the Tube yesterday, along the lines of ‘We go to mortgage hell so you don’t have to’.
‘Home is where the heart is’
A graph of mortgage prices in Australia from 1965-2010 shows that, in 1965, the average house ($9,400) cost 2.9x the average annual wage ($3,193). By 2010, the average house price ($524,500) had risen to 7.8x the average annual wage ($67,116). Meaning, house prices had increased in relation to wages by 2.7x. Mortgage payments also (unsurprisingly) increased over this time. In 1965, mortgage payments took up around 37% of the average wage. In the late 2000s, this had increased to over 85%.
So why do mortgage payments appear to take up so much more of our income now than 50 years ago?
Is it all just inflation and the housing bubble? Why haven’t our incomes kept pace?
Here are some ideas:
1. Buying bigger, better houses:
Now, we already know that, in real terms, a house in 1965 cost 2.7x less than in 2010.
But, you were also getting less house!
In 1950 (the closest figure we have to 1965), the average house was only 200 square meters, while in 2005 (the closest figure we have to 2010), the average house was 325 square meters – an increase of 125 sqm or 62%. Land has, however, decreased in size, and some blame slow release of land by the government for high property prices. Even so, 62% larger houses, and plenty of other features- like home theatre rooms, ensuites, spas, dishwashers, walk-in-robes etc. – are bound to add cost to house prices.
Of Australia’s 8.6 million households, 6.4 million are family groupings (including childless couples) – the rest (2.2 million) are people living alone.
And of those 6.4 million family groupings – just 2.4 million are families with children under 15.
So of the 8.6 million households, 2.2 million have just one occupant. Four million are childless couples, or parents with older teenage kids, likely to leave home in the next 3-7 years.
Bearing this in mind, do we all need a 325 square meter house?
We always hear about the average house price, but what about the average unit price? While a house in Melbourne might go for $500,000, a one bedroom unit can be found for $100,000-300,000. That’s a crazy 1.5x to 4.5x the average wage. In other words, it is still possible to buy a dwelling that is cheaper than homes were in the 1960s, so long as you are happy to let go of the dream of the white picket fence. I’m not saying this is for everyone, but it is something to consider.
2. Saving less and borrowing more:
It used to be the case that you needed at least a 20% deposit to be taken seriously by a bank. Then, higher loan to value (LVR) mortgages became possible. You could borrow 95%, even 100%. Heck, at one point, it became possible to borrow 105% so you could finance a holiday along with your house! Consider the following scenarios:
- Abby and Bobby save a 20% deposit for their $500,000 house ($100,000, meaning they borrow $400,000). Because they have a 20% deposit, they do not need to pay lender’s mortgage insurance (LMI). Their initial minimum payments are around $2,398 per month.
- Carrie and Derrie save a 5% deposit for their $500,000 house ($25,000). As their deposit is lower than 20%, they need to pay LMI of around $15,000, meaning they borrow $490,000. At the same interest rate, their initial minimum payments are $2937 per month.
- Eddie and Freddie do not save any deposit and borrow the full amount for their $500,000 house. They need to pay LMI of around $20,000, meaning they borrow $520,000. Their initial minimum payments are $3118 per month.
- Gabby and Halley do not save any deposit either, and they borrow 105% for their $500,000 house so that they can have a nice holiday after their big move. They need to pay LMI of around $25,000, meaning they borrow $550,000 including the holiday amount. Their initial minimum payments are $3298 per month.
Abby and Bobby, who have the 20% deposit, get to pay around $1000 per month less than Gabby and Halley. Abby and Bobby’s mortgage will cost them $28,776 over the first 12 months – equivalent to around 42% of the average wage.
Gabby and Halley, at the other end of the spectrum, will have to pay $39,576 in the first 12 months – equivalent to around 59% of the average wage.
3. Dual incomes and disposable cash:
Calculating house affordability with reference to the average wage masks an important change in our society – the increased participation of women in the workforce, and as a result, the increased number of dual income families. Of course, many more households in the 2000s have two incomes than did households in the 1960s. A household with two average wage earners and an average mortgage payment would, therefore, be spending not 85% of their combined wages on the loan payments, but 43% of their combined wages, a figure much more similar to 1960s payment rates.
While there remain a not insignificant number of couples and families with a single income, the number with two incomes has undeniably increased:
Statistics reported in the Daily Telegraph show that last year, of coupled families with children, two thirds had two incomes (either both full-time (25%), one full-time and one part-time (26%) or two part-time (5%)), while in the 1980s, only half of families had two incomes, and only 17% had two full-time incomes.
I suspect that the number of dual income families would have been even lower in the 1960s.
With double-income rather than single-income now the largest category when it comes to families, it stands to reason that a better measure of the affordability of homes would be to consider mortgage payments and house costs as a percentage of the average household income rather than the average wage.
The 85% reported by the graph at the beginning of my post, for example, seems terrible and almost unliveable – if one is on an income of $67,116 and spending 85% of that figure ($57,049 a year) – leaving only $10,067 to feed and clothe oneself and perhaps 3 or 4 dependents (let’s say a family of 5 – that’s only $38 per person per week). Such a loan is highly unlikely to be approved by any bank, who would deem it ‘unservicable’. So surely there’s more to the story.
If, however, one has a dual income family with two average wages of $67,116 (a combined income of $134,232) $57,049 mortgage repayments – while still very high – suddenly appears a lot more achievable. Rather than $10,067 left over, there is $77,183 left over – a massive $296 per person per week instead.
To look again at the characters from the start of my post, if both Abby and Bobby held average jobs, their mortgage repayments will be equivalent to just 21% of their overall income, not 42%.
Gabby and Halley, while still having a higher payment, if both have average jobs, will need only pay 30% of their overall income, not 59%.
Even when the second income is only part-time, this can help matters immensely. In the example above with the family of five, and just $38 per person per week after mortgage payments – think of the difference that a part-time income of $10,000 could make, increasing the family’s available cash from $38 per person per week to $77 per person per week. And with $20,000 part-time income, their mortgage repayments would chew up not 85% of their income, but just 65%. This is still much too high, but provides more of a buffer.
Work to live, don’t live to work
Of course, I’m not in any way advocating people work just to afford giant mortgages. Rather, I think that a measure that takes into account family structures would be more realistic. And while, in some ways, it is easier to have two incomes, this is not always the case. At least one article warns of the ‘two-income-trap‘ – as with so many things, it’s not what you earn, but how you spend it.
As my previous post showed, many items on sale today are actually cheaper than in the 60s or 70s. So even though housing is more expensive, there are other areas we can make savings in. The main difference is in our expectations – how many televisions or computers did the average house have 60 years ago?
We also need to consider that the nuclear family and the traditional three-bedder does not apply to everyone, and be wary when listening to or reading the news – if you’re not looking for the traditional home, the figures you hear bandied about may apply only loosely to your purchase of an apartment or unit or townhouse.
Likewise, simply because I have used ‘average’ housing figures (of around $500,000 for Melbourne – I could not find similar stats for other cities/states which had such a comprehensive chart) doesn’t mean that I’m advocating buying an ‘average’ house. I personally don’t have an ‘average’ home or anything close to it. And I believe this is one of the keys to affordability – thinking outside the box.
So… is it harder to buy a house these days?
In short, yes and no.
Incomes are 21x higher than they used to be in 1965, and house prices are 56x higher.
Mortgage repayments carve up more of our income than ever before.
On the other hand, houses are 62% larger – not to mention all the other extras which aren’t easily quantifiable.
And people have tended to save less and borrow more. This also increases mortgage payments (although this may have reversed post-GFC).
Houses in the 1960s cost about $47 per square meter, nearest I can tell. In the 2000s, they were $1,613 per square meter.
That’s an increase of 34x on a per square meter basis- not 56x.
It’s still a massive increase, but perhaps not as massive as we are often led to believe. Especially when you consider very few houses in the 1960s would have come equipped with ensuite bathrooms with underfloor heating, heated and automatically lit walk-in-robes, spa baths, powder rooms under the stairs, dishwashers, garbage disposal, instant hot water dispensers, ducted heating and vacuums, dimmer switches and USB plugs in wall sockets and so on, pricey fixtures that drive up the cost per square meter. Yes, I know that not all houses have these extra features, but they’re surely more prevalent now.
And of course, many other things, especially electronic appliances, clothes, and other small goods, as well as many food stuffs, have remained the same, or decreased drastically in price. So even though houses have gone up substantially, the cost of living in other areas may be more affordable.
Do prices always go up?
Of course, while inflation is often a normal part of the economy, and we generally expect housing prices to increase, as I have emphasised throughout this series of posts, inflation and capital growth doesn’t always occur at a steady rate, or even at all.
Sometimes, when a bubble in housing or another commodity becomes over-inflated, it bursts.
The term ‘mortgage hell’ referred to in the Tube advertisement appears to be in pretty common use – a 2008 Glamour article titled ‘Welcome to My Mortgage Hell‘ was the first hit on my DuckDuckGo search, and describes the terrifying situation of what we have come to know as an ‘underwater mortgage‘ – where the loan’s balance is higher than the market value of the home.
Mortgage planner Robert McLister offers some tips to ensure you don’t owe more than your home is worth:
- Rent a little longer to save up a bigger down payment
- Buy a home as a long-term hold
- Make extra prepayments when possible
- Don’t overpay
Our tips, after first becoming homeowners (albeit of a small apartment!) in our mid-20s – around a decade earlier than average – are to:
Be modern in your lifestyle and old-fashioned in your finances:
- Save up the largest deposit you can- aim for 20% or more. You’ll save literally thousands of dollars on LMI. And tens or hundreds of thousands on interest over the term of your loan.
- Start off small with a ‘starter home’ – or, better still, re-think what you really need.
- Pay off as much as you can as quickly as possible.
My point isn’t that inflation isn’t important, but that the media has a vested interest in selling fear, and you shouldn’t give up based on fear mongering.
If you are willing to right-size your dreams, buying your first home in your early 20s is still very achievable.
What does the word ‘home’ mean to you?
Today’s featured image is the 13th century mortgage brick at the British Museum.